-Analysis-

BUENOS AIRES — As then President Juan Domingo Perón made clear in a 1951 speech, concerns in Argentina over the price of the U.S. dollar are nothing new. "I ask you this," he said. "Why do you want dollars? Who's ever seen a dollar?"

Perón posed the question to political opponents who were complaining about a shortage of dollars in one of the country's recurring currency crises, because even then, the U.S. dollar was something Argentines wanted and paid attention to. Since then, the interest has only grown.

Official statistics indicate that more than a million people in Argentina buy dollars intermittently on the official exchange market. And Argentines are thought to be holding at least $300 billion worth of foreign currencies, a staggering amount given that our peso-denominated financial assets are less than $90 billion.

Who's ever seen a dollar?

How did we get here? The answer is simple: Inflation, which destroys the purchasing power of the Argentine peso by reducing the amount of pesos people hold, and by eliminating its ability to act as a unit of account in the system. Why are big economic transactions priced in dollars? Because uncertainty over the peso's purchasing power makes it difficult to use to settle future transactions. We use a unit of account, therefore, that shows greater long-term stability.

As mentioned above, more than 75% of people's financial assets in Argentina are denominated in dollars. And so it's only natural that they worry about fluctuations in the exchange rate, which can also impact monetary policy.

Backing off LEBACs

Investors much prefer an interest rate in dollar terms than in terms of (real) purchasing power, so changing interest rates have more of an impact on the composition of portfolios than on demand for goods and services. The recent exchange-financial crisis was a clear example of this.

For tax reasons, and because of currency devaluations in neighboring countries, foreign investors became concerned about peso returns on Central Bank-issued, short-term securities known as LEBACs (Letras del Banco Central). Those worries prompted a selloff, with people buying dollars instead.

Uncertainty over the peso's purchasing power makes it difficult to use to settle future transactions.

This action does not have significant economic effects per se, as it simultaneous reduces a Central Bank asset and liability (reserves and LEBACs respectively). Essentially it reverses an operation that should never have happened in the first place, namely the entry of foreign capital to buy LEBACs, in response to rising interest rates in Argentina.

But it could have had grave economic effects if Argentines also decided to dollarize their portfolios. Fortunately that didn't happen. Between April 20 and May 11, the total stock of Lebacs remained nearly constant, but with a great increase in holdings by financial entities and a somewhat greater drop in holdings by foreign investors and funds.

The entities financed their purchases by selling other financial holdings, and sellers used the funds to buy currencies. At the same time, if we observe the private sector's total holdings of peso-denominated financial assets, we notice an increase of more than 80 billion pesos ($3.3 billion). In short: this was a crisis for Lebacs where foreigners reduced their holdings without, fortunately, affecting the portfolios of Argentines.

Trouble ahead?

The economy will inevitably be impacted by the recent fluctuations, though it is too early to say how much. As Nicolás Dujovne, the government's chief economic coordinator, stated, inflation will be greater than forecast due to the direct and indirect effects of a rising dollar.

Economic activity will also increase less than expected, given the need to reduce the current account deficit (with more restricted credit), deteriorating public confidence and spending decisions.

Ultimately, what holds the economy together is confidence. With confidence, I spend, invest and take risks. Without confidence, I stop spending and try and keep what I have, helping generate an economic implosion.

Inflation will be greater than forecast due to the direct and indirect effects of a rising dollar.

Figures from recent weeks showed very positive growth data, allowing forecasts of 4% GDP growth in the first quarter of 2018. Those of the second quarter will clearly be inferior, because of drought, tighter credit and falling confidence. But as I've pointed out before, the real cause of this and previous crises is the tendency to overspend, using credit facilities and ignoring the fact that sooner or later, creditors will start doubting our ability to repay.

That is when they will stop financing us and make us abruptly reduce our spending. And that is exactly what is starting to happen, independently of the recent crisis.


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